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Mutual Funds: The journey from ‘Collective

Lending’ to ‘Wealth Creation’


"Wide diversification is only required when investors do not understand what they
are doing." - Warren Buffett

 Sharad Kumar*

The quote of Warren Buffett aptly fits the area of This phase did not last long and it was soon realised
our reading. Mutual Fund is all about diversification that the banking system and the non-banking financial
and creation of wealth in a relatively non-complex intermediaries have the capabilities to create a supply
risk – return matrix. We all are living in a financially of investment which can be far above than the “forced
integrated world and it would not be any exaggeration savings”, as thought before. There have been a series
if we say that it is the global inter-flow of capital which of institutional changes in the last quarter of the 19th
is fuelling the growth and development of the world century which has also seen a subtle shift from the
economy. Money is a resource, which drives up the “only Credit” based system to a “financial” system,
business and growth of the economies. While money wherein, in addition to the banks, we have insurance,
is required for the businesses to run, the investors are pension funds and mutual funds playing an important
also always on a lookout for enhancing their returns. role in the growth and development of the economy.
This creates a symbiotic relationship in which one of Though, there is an exhaustive list of funding channels
the entities needs funds at competitive pricing and as well as investment avenues available in the
another entity wishes to have the best returns on his/ market, mutual funds stand high as one of the tools
her investible surplus resources. which provide better side of both the instruments.
As against the factors which increase the risk of
Augmenting Wealth: The rise of Mutual Funds
investing in instruments such as capital market, bond
In one of the insightful writings on Mutual Funds by market etc. or the relatively lower returns on low risk
Sadhak H, (2003), he said that, ‘The importance of instruments, mutual funds provide an option of getting
financial development was amply acknowledged by better returns without compromising on the risk
classical economist (Adam Smith and others) and perspective. Mutual Funds also are large subscribers
neo- classical economist (Alfred Marshall and others), of Commercial Papers (CPs) and generates returns
who believed that there is a close relationship between from equity market by subscribing to public issues
capital accumulation and the process of economic in primary market and by also actively playing in the
development. However, the importance of financial secondary market. It provides the volume boost to
factors in the development process was largely the investment being made in the market.
ignored and forced savings were considered the best
The Mutual Fund Journey:
means for financing development. But, ‘the resultant
financial repression is thought to be a major cause of It would be imprudent to discuss about Mutual funds
low savings rates and the underdevelopment of the without analysing its origination. The investment
financial sector’ (Hossain and Choudhury, 1996). option or the tools made available historically,

*Assistant General Manager, State Bank of India.

16 January - March 2019 The Journal of Indian Institute of Banking & Finance
emerged as an outcome or solutions to the politico– people as subscribers to his pool and drew an
economic issues of that time. Mutual fund was also Investment Trust, which later came to be known as
one of them. Another striking feature worth noting is the world’s first Mutual Fund, way back in the year
that the roots of mutual fund lies not as an investment 1774. The key element of this pool of funds was the
avenue but as a lender of what we can call now as diversification of financial risk which was achieved
collective lending by people to mobilise large chunk by having subscribers from different countries and
of money in the absence of any alternate source. colonies of US etc., where the investments were
It is said that necessity is the mother of invention. If backed by income from activities such as plantations.
not completely, at least, if we trace back the financial In the same year, 1774, Abraham van Ketwich, a
history of the Mutual Funds, we would see that it was Dutch broker invited subscriptions from investors to
an outcome of a financial crisis, which hit Europe in form a trust named Eendragt Maakt Magt-the maxim
the early 1770s. The history gets closely connected of the Dutch Republic, “Unity Creates Strength”. The
to India as at that point of time, we were also one of fund, created by Van Ketwich’s, survived only till 1824
the colonies of the British Union. No one of us would but, the concept he created is still considered as a
be oblivious of the history of India. It was in the early symbol of personal investing.
1600’s during the reign of Mughal Emperor Jahangir
As already discussed in the beginning, the Mutual
that the East India Company first approached India
Fund journey began as a lending concept, but
to establish a factory. In the years going forward, the
coming back to the present times, the first modern-
British East India Company had to resort to heavy
day mutual fund was Massachusetts Investors
borrowings which could fund its colonial expansion
Trust, which got its foundation laid down in the year
plans, beginning with North America. As with any
1924. Now, we have open ended and close ended
industry, the expenses continued to increase without
schemes, however, during that period it was the first
a matching revenue from the colonial business
mutual fund with an open-end capitalization. In just a
interests. Eventually, the company sought financial
time span of one year, the fund catapulted itself with
refuge with the British Treasury in 1772. However, to
their ill-fate, the British treasury was already passing much force and grew from an asset size of $50,000
through period of financial stress. In the current milieu, to a size of $392,000. The fund later became to be
we can relate it to a situation of a systemic important known as MFS Investment Management after going
company failing in business causing a ripple effect public in the year 1928.
on the business across nations and across the world. Mutual Funds in India:
History would let us know that the Dutch, English and In India, the first mutual fund was launched in the year
the Portuguese were all traders putting all their efforts 1964, though it continued to move at a very slow pace
in capturing the market to generate revenues. During until 1980s. This phase was dominated by UTI. It was
this period the Dutch who were very aggressive in the late 1980s that non-UTI public sector mutual
merchants, were also exploring the world across funds also entered the market and the first in the
seas in search of business opportunities. While the
series was SBI Mutual Fund which was launched by
opportunities were there, so were the challenges of
SBI in November 1987. This was followed by Canbank
business and financing.
Mutual Fund and LIC Mutual Fund and others. The
At this crucial juncture, it was a Dutch Merchant final phase of the mutual fund history in India can be
Adriaan van Ketwich, pooled money from multiple traced back to 1993, when the market was opened

The Journal of Indian Institute of Banking & Finance January - March 2019 17
for the private sector funds. The first of such fund was Investopedia does provide a definition, which says
Kothari Pioneer Mutual Fund in November 1993. This that Diversification is a technique that reduces risk
was followed by ICICI, 20th Century, Morgan Stanley by allocating investments among various financial
and Taurus Mutual funds. instruments, industries, and other categories. It aims
to maximize return by investing in different areas
The free entry of Mutual Funds exposed the Indian
that would each react differently to the same event.
market to some inherent weaknesses in the Indian
Most investment professionals agree that, although it
financial market. The loose links found during this
does not guarantee against loss, diversification is the
period were tightened through several measures
most important component of reaching long-range
initiated by SEBI from 1995-96 to 1999-2000 to
financial goals while minimizing risk.
streamline the operations.
An investment is always subject to risk and return
In India, the Mutual Fund industry is regulated by
matrix. The more the expected return, more would
SEBI. The industry is also supported by Association
be the risk. Though, any Investment is subject to a
of Mutual Funds in India (AMFI), which is dedicated
large variety of risk, it can be basically classified into
to developing the Indian Mutual Fund Industry on
systematic risk and unsystematic risk.
professional, healthy and ethical lines and to enhance
and maintain standards in all areas with a view to The systematic risk also called as market risk or
protecting and promoting the interests of mutual undiversifiable risk is at the macro level and is
funds and their unit holders. applicable to all the companies or industries operating
within a relatively common environment. It may relate
Why Mutual Funds?
to factors such as inflation, exchange rates, political
Any individual with surplus funds can move around instability, war, interest rates or other macro numbers.
in the market and choose one of the many available This kind of risk is not company specific or industry
investment options, which may be offering assured specific and is quite generic in nature, it cannot be
returns such as bank deposit or government saving managed through diversification at individual micro
schemes or variable returns in options such as stock level. This gets managed by a combination of factors
market. In case of an enterprising risk taker, he or which require policy interventions at global and
she can venture into the domain of segments such national levels, and so have to be as such built into
as futures and options or commodity trading etc. The the risk calculations.
question arises, then why Mutual Funds has emerged
The second type of risk is the unsystematic risk. This
as one of the best available asset classes. Is it an
risk is associated with a specific company, industry,
income maximising tool; a risk optimising instrument
market, economy, or country and can, therefore, be
or may be a speculative investment. What exactly is
controlled through diversification. Though there are
it? Let us try to unravel this mystery and understand
a number of risk factors, the most common sources
things better from an investor’s, perspective.
of unsystematic risk are business risk and financial
In case of Mutual Funds, the best premise what risk. The aim of an efficient Fund Manager, therefore,
I understand is that of risk diversification, better should be to ensure that the investment of the pooled
portfolio allocation and the best risk-return matrix. resources is done in such a way across various
Though, there cannot be a strict definition of assets so that they do not get affected the same way
Diversification, it being an investment concept, by market events.

18 January - March 2019 The Journal of Indian Institute of Banking & Finance
Why Should You Diversify: Performance of MFs in India:
In the financial world, the birth of Mutual Funds as an As on March 31, 2018, there were 45 mutual funds
investment option was nothing less than a revolution registered with SEBI, of which 34 were in the private
in itself. The investing power, hitherto, being thought sector and seven (including UTI) were in the public
to be with the affluent class tricked down to the sector.
common small investor community and the people
with little surplus money got an option of pooling The number of Indians investing in capital markets
their resources to a fund management firm, which has traditionally been low, and most of the people
was professionally managed and ensured that the parked their funds in bank deposits. But, a study
money received from small retail investors is put in a shows that mindset is slowly changing; as bank
diversified basket of investments. This was as against deposit rates fell, mutual funds have been able to
the expensive proposition of purchasing individual garner a proportionately higher share of household
stocks carrying different risks. savings.
We are hearing a lot on the oil prices front, so let us The growing potential of Mutual Funds gains
take the same example and assume that you have resonance with SEBI mentioning in its annual report
a portfolio of oil stocks only. In case of an increase that ‘buoyed by robust capital inflows and strong
in global oil prices, the downstream sector of oil and participation of retail investors, the asset base of
gas industry would suffer and your portfolio may the mutual fund industry again produced record
suffer. However, if you would have taken other sectors
breaking numbers in 2017-18. The Average Asset
of industry in your portfolio, the chances of balancing
Under Management (AAUM) of MF industry for
the loss with gain in others would be higher. This gets
the year 2017-18 was `21.46 lakh crore. However,
more balanced if you add retail stocks also in the
mutual funds AUM to GDP ratio of 12.8 per cent in
bucket to further diversify. The key lies in the mix. The
2017-18 indicates a large untapped market potential
more unrelated and uncorrelated your stocks are, the
better prospects are there for minimising the losses. and very low penetration vis-a-vis global and peer
benchmarks’.
If we think one step further, it is important to diversify
among different asset classes. Different assets - such Between 2014-15 to 2017-18, Assets Under
as bonds and stocks - will not react in the same way Management (AUMs) of mutual funds doubled from
to adverse events. A combination of asset classes will `10.83 lakh crore to ` 21.36 lakh crore. (According
reduce your portfolio's sensitivity to market swings. to AMFI data, the Asset Under Management (AUM)
Generally, bond and equity markets move in opposite of the industry, comprising 42 players, climbed from
directions, so if your portfolio is diversified across `22.23 lakh crore at the end of October, to `24.03
both areas, unpleasant movements in one will be lakh crore in November-end). In comparison, bank
offset by positive results in another. deposits rose about 34 per cent to `114.26 lakh crore
In case of investment in mutual funds, you are not from `85.33 lakh crore in the same period. While the
tied up with a certain stock or a group of stocks. bank deposit pool remains significantly large, the
On top of this, you are not alone and responsible steady increase in the share of mutual funds in total
for the ups and downs you face in your investment. incremental savings deployed in deposits and mutual
The most conventional view argues that an investor funds increased from 12.6 per cent in 2014-15 to
can achieve optimal diversification with only 15 to 20 around 19 per cent in 2017-18.
stocks spread across various industries.

The Journal of Indian Institute of Banking & Finance January - March 2019 19
The table clearly reflects the growing influence of If we see the growth pattern also, then we would see
the mutual funds as an alternative safe investment that the growth of AUM has been relatively higher
avenue, which so far was only deposits. than the deposit growth, though the variations are
Mutual SCBs Agg MF as a %age also on a higher side owing to the risk and volatility
Year
Fund AUM Deposit of Deposit attached to the mutual fund investment as compared
Mar-93 0.48 2.69 17.77 to the deposit which offer a lower but risk free return.
Mar-03 0.79 12.81 6.25
Deposit Growth Vs MF AUM Growth
Mar-04 1.40 15.4 9.28 100%
Mar-05 1.50 17.00 8.80 80%

Mar-06 2.32 21.09 10.99 60%

Mar-07 3.26 26.12 12.50 40%

20%
Mar-08 5.05 31.97 15.80
0%
Mar-09 4.17 38.34 10.88

04

05

06

07

08

09

10

11

12

13

14

15

16

17

18
-20%

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-

n-
Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja

Ja
Mar-10 6.14 44.93 13.67 -40%

Mar-11 5.92 52.08 11.37 AUM Growth (YoY %) Deposit Growth (YOY %)

Mar-12 5.87 59.09 9.94


Mar-13 7.01 67.50 10.39 The increasing interest of the household investors
Mar-14 8.25 77.06 10.71 towards mutual funds or other asset classes like this
Mar-15 10.83 85.33 12.69 gets corroborated, when we see the movement in the
Mar-16 13.50 93.27 14.47 household savings.

Mar-17 18.29 107.58 17.00


Mar-18 21.36 114.26 18.69

Average Average
Components 2011-12 Eleventh 2012-13 2013-14 2014-15 2015-16 2016-17 Twelfth
Plan Plan
Gross Savings in Financial Assest 11.1 13.7 12.4 13.8 15.0 16.1 16.4 14.7
Net House hold Financial Savings 8.0 10.4 9.0 10.0 10.8 11.6 11.9 10.7
House hold savings physical assets 14.3 13.0 13.2 12.7 12.2 11.7 11.7 12.3
House hold savings total 22.3 23.4 22.8 22.7 23.0 23.3 23.6 23.0
Savings by the private corporate sector 7.2 8.1 7.3 7.7 8.0 8.5 8.5 8.2
Savings by the public sector 1.3 2.0 1.5 2.0 2.5 3.1 3.9 2.7
Gross Domestic Savings 30.8 33.5 31.0 32.4 33.5 34.9 36.0 33.6
Finance for Investment 35.0 36.1 35.8 36.2 36.5 37.7 38.5 36.9
Sorurce Planing Commission

20 January - March 2019 The Journal of Indian Institute of Banking & Finance
The table above clearly shows that the gross savings in as an asset class, which indicates that there has been
the financial assets have been increasing consistently a movement of customer to equity oriented MFs,
and this shows the confidence of the households in which hitherto was focussed only on the balanced
financial assets. funds. One of the reports published by Care ratings
says that there has been an increase in the share of
The data indicates that the investor community is
growth or equity schemes with the share moving up
becoming comfortable with the financial markets
from 24.6% to 35.1% during the period between 2012
and the mutual fund route is the best way to ensure
and 2018.
retail participation in the equity and debt market of
the country. As the economy is growing, the financial markets are
also evolving. Rise of Mutual funds as an alternative
The economy as such is passing through a declining
asset class for investment returns is a sign of financial
interest rate cycle, which may continue for some more
deepening. It draws a simile to the rise of other
time to assuage the credit market and provide them
sources of credit such as external borrowing, bonds
succour in the form of affordable lending rates. While
etc. other than the traditional means of bank credit.
this is also critical to support the business community
in times of stress, in such a scenario, a risk averse References:
investor looks to other risk mitigated investment
1. Sadhak H. Mutual funds in India: Marketing
avenues of which Mutual Fund emerges as the best
Strategies and Investment Practices. 2nd Ed.
option. Response books. 2003.
Conclusion: 2. h t t p s : / / w w w. i n v e s t o p e d i a . c o m / i n v e s t i n g /
importance-diversification
The risk appetite of a common customer has been
increasing over the period. The customers are 3. The Investment Funds Institute of Canada. The
History of Mutual Funds
looking out for better returns and are not feeling
shy of making investments in slightly riskier assets. 4. Care ratings. Growth of the Mutual Funds Industry
Mutual fund gives them the opportunity of choosing in India. May 2018
their returns based on the individual risk appetite of 5. ( h t t p s : / / w w w . t h e w e e k . i n / n e w s / b i z -
the customer. While the trend can be further firmed tech/2018/05/03/indians-investing-more-in-
mutual-funds-than-bank-deposits-study.html
up after couple of years, there is another view coming
out in relation to their preference within Mutual Fund 

BANK QUEST THEMES FOR NEXT ISSUES

The themes for next issues of “Bank Quest” are identified as:

• Ethics & Corporate Governance in Banks: April - June, 2019

• Emerging technological changes in Banking: July - September, 2019

The Journal of Indian Institute of Banking & Finance January - March 2019 21